Consistent Valuation of a Finite Stream of Cash Flows with a Terminal Value

Abstract: If the forecast period is short, then the specification of the assumption for the calculation of the terminal may be an important element of the valuation exercise. To be specific, with respect to the reference year 0, the (present) value of the terminal value may be more than fifty percent of the total levered value. In this teaching note, we present a numerical example that values consistently a finite stream of cash flows with a terminal value from three different points of view: the Adjusted Present Value (APV) approach, the Capital Cash Flow (CCF) method and the traditional after-tax Weighted Average Cost of Capital that is applied to the Free Cash Flow (FCF). We assume an M & M world.